DISCLAIMER: This post is for people (like me), who know absolutely nothing about buying and financing a home.
A 3% down payment sure does sound attractive…. however, think carefully before you leap. Last month, two government-backed mortgage giants, Fannie and Freddie, announced a new loan program targeting first-time home buyers. Under the program, a buyer could put down as little as 3% for a home. (So in theory, if you wanted to buy a $300,000 home, under this program, you’d only have to put down $9,000 – a down payment that is massively smaller than paying the traditional 20% down payment at $60,000. And yes, the latter takes years to save up for).
Several respectable media outlets covered the news, including the Washington Post, USA Today, AOL and TIME. When I first saw the headlines, I’d be lying if I said I wasn’t immediately hooked. If the new program is as good as it sounds, why the hell wouldn’t I buy?? Luckily, my parents raised me to be… suspicious.
However, without knowing anything about mortgages, finding the “catch” in the stories referenced above wasn’t easy. Which is a shame, because journalism owes it to the public to be more thorough and objective. The stories all noted that under the new program, first time buyers would have to pass strict criteria, including good credit scores (620-650+) and completion of a home-buying education program. Easy enough.
But after digging more deeply, I came across this Consumer Affairs article that finally, more clearly identified the “catch.” Reporter Mark Huffman points out:
Because of the small down payments, these loans will also require private mortgage insurance (PMI) or other risk sharing. On a 3% loan, consumers should expect to pay a little over 1% of the loan as premium. In our example of a home costing $130,000 with $3,900 down, PMI would add about $110 to the monthly house payment.
Finally, a better picture of what a small down payment actually means for buyers! Thank you, Mr. Huffman. To make this a more realistic scenario (since $130k homes are rare in Chicago), that means for anyone interested in buying a $300,000 home, PMI could cost $3000 a year or $250 monthly on top of regular mortgage payments. (Note: This is money that is just paid and lost; it goes nowhere). Not to mention that a small down payment significantly drives up the monthly cost of your mortgage.
After digging even further, I found another helpful article that details another reason why first-time home buyers should avoid PMI. In addition to the cost, it talks about the negative tax consequences PMI has for couples who earn more than $110,000 annually together or $55,000 annually separately. Check it out here.
While I don’t want to automatically write off programs that accept small down payments, the moral of the story is to research, research, research! Otherwise, maybe we’d all end up like this individual:
… I was very ignorant when I purchased my 1st house at 25 years old! A combination of empty/mis-leading promises from my mortgage broker and just being so excited to be a homeowner got me into SERIOUS financial trouble!
I have been in my home for almost 5 years and have been paying $500 per month in PMI. I was told it would automatically end after 2 years. My monthly mortgage payments are about $1700 per month with PMI for a little two bedroom townhouse in Hudson, WI.
You can read the rest of this person’s story here, but you get the idea. Although a 3% down payment sounds wonderful on paper, it would take a lot of research and math to figure out if it’s actually worth doing over renting and/or saving for a more traditional down payment.